Kern River Expansion
North America Oil & Gas Deal of the Year 2002
Kern River Expansion
Kern River has been a prized asset to project lenders for several years ? since its first construction financing in 1992. In the teeth of a truly appalling environment for power project finance, the mainstay of US lending, the $1.2 billion Kern River Expansion deal was nothing short of a godsend to frustrated bankers. It stood out clearly from the bulk of US loans as the only piece of paper participants were generally proud to own, even if it will only stay on their books for one or two years.
The Kern River pipeline carries gas from the Northern Rocky Mountain region down into the Southern Californian market. This basic proposition would normally be enough to get interest from lenders on its own merits, given the growing prominence of gas-fired capacity in the state, as well as well-publicised power shortages and a concomitant rush towards new gas plants. Indeed, Kern is much beloved of the Federal Energy Regulatory Commission (Ferc), which sees it as useful means of bringing down gas and power prices in the state. Indeed, Ferc is currently moving towards a decision about whether an El Paso pipeline into the state withheld capacity to shippers.
Kern will not face this scrutiny for the same reason that its debt is such a hot prospect ? its capacity is tied up in rock solid ship-or-pay contracts. These include a number of merchants whose ratings have slipped somewhat in recent months but are still in high investment grade territory. Its original sponsor was Williams, one of the pioneers of deregulated energy markets. Since then, Williams, largely as a result of its forays into telecoms ventures, has encountered cashflow difficulties, has had its rating cut, and has been forced to sell its interest in the pipeline to MidAmerican Energy.
The core of MidAmerican is CalEnergy, an independent power producer that also ran into trouble. Since then, MidAmerican, a company controlled by Berkshire Hathaway, Warren Buffett's investment vehicle, has gained a reputation as a company that buys astutely at the bottom of the market. It has since made very lucrative loans to Williams and CentrePoint, and project lenders had hoped that it might be a source of dealflow for their parched loan books.
But Kern River is, and remains, even after a series of changes in finance personnel, a standalone company. It is fiercely protective of its A3/A- rating ? one of the best in project finance. Indeed, much of the history of the pipeline's financing has been that of keeping the cost of borrowing as low as possible. It has led to a number of skirmishes with regulators over the costs of swaps, and has been a key factor in the retention of Credit Suisse First Boston (CSFB) as financial advisor, frequent bookrunner and lead arranger of its debt.
CSFB ran a bond in August 2001 to refinance the pipeline's debt, the fourth such effort, and the sale of the project to MidAmerican, for $450 million in cash and $150 million in assumed debt, made little impact on the line's financing strategy. CSFB was joined, however, by MidAmerican relationship bank Commerzbank, and CalEnergy bank Union Bank of California as mandated lead. What resulted was the loan equivalent of a mayfly ? a gorgeous, if short-lived, asset. Indeed, the only reason that it has such a long tenor ? 15 years ? is that the structure needed to be amortizing but could not deprive existing bondholders of too much cashflow.
The goal for the arrangers was to assemble a short-term package that would not interfere with existing debt but prove sufficiently saleable to banks. The indentures for the bond refinancing made clear that further debt would be raised on the project, and would share a security interest with bondholders. One incentive for existing investors was that the expansion had additional contracts in place of roughly the same creditworthiness.
The $875 million in bank debt will be taken out as promptly as is possible, and only exists because of the traditional aversion of bond investors to construction risk. A wrap from MidAmerican, therefore, covers the possibility of the expansion missing its due date for completion. Once this date is reached, a bond take-out of the debt waits simply upon favourable capital markets conditions.
The pricing on the debt carries clear penalties for delaying an issue, largely in terms of pricing. Nevertheless, the fact that the loan, which carries an 18-year term, will probably be prepaid in the second quarter of this year did not discourage participant banks from piling in, attracted by the fees as well as the temporary sweetening of battered loan books. Moreover Kern has a very solid relationship following in its own right.
Kern River does not presage any new financings from MidAmerican ? its acquisition of the Northern Natural Gas pipeline from Dynegy used corporate funds. However, as the largest non-recourse deal in the US, and the only significant non-power deal there, it came as useful succour to lenders, several of whom had to accept lower hold levels than they would have liked. Still, with pricing on the debt starting at 137.5bp over Libor, and manager roles fetching 70bp, most will be sorry to see the debt go. A refinancing is tentatively set for the middle of this year.
Kern River Transmission Company
Status: closed June 2002
Size: $1.2 billion
Location: Western US
Description: financing of an expansion to existing pipeline assets
Sponsor: MidAmerican Energy
Debt: $875 million
Arrangers: Commerzbank, Credit Suisse First Boston, Union Bank of California
Tenor: construction plus 15 yeaars
Lawyers to the borrower: Wilkie Farr & Gallagher
Lawyers to the lenders: Skadden, Arps, Slate, Meagher & Flom
Market consultant: Pace Global Energy
Kern River Expansion
Kern River has been a prized asset to project lenders for several years ? since its first construction financing in 1992. In the teeth of a truly appalling environment for power project finance, the mainstay of US lending, the $1.2 billion Kern River Expansion deal was nothing short of a godsend to frustrated bankers. It stood out clearly from the bulk of US loans as the only piece of paper participants were generally proud to own, even if it will only stay on their books for one or two years.
The Kern River pipeline carries gas from the Northern Rocky Mountain region down into the Southern Californian market. This basic proposition would normally be enough to get interest from lenders on its own merits, given the growing prominence of gas-fired capacity in the state, as well as well-publicised power shortages and a concomitant rush towards new gas plants. Indeed, Kern is much beloved of the Federal Energy Regulatory Commission (Ferc), which sees it as useful means of bringing down gas and power prices in the state. Indeed, Ferc is currently moving towards a decision about whether an El Paso pipeline into the state withheld capacity to shippers.
Kern will not face this scrutiny for the same reason that its debt is such a hot prospect ? its capacity is tied up in rock solid ship-or-pay contracts. These include a number of merchants whose ratings have slipped somewhat in recent months but are still in high investment grade territory. Its original sponsor was Williams, one of the pioneers of deregulated energy markets. Since then, Williams, largely as a result of its forays into telecoms ventures, has encountered cashflow difficulties, has had its rating cut, and has been forced to sell its interest in the pipeline to MidAmerican Energy.
The core of MidAmerican is CalEnergy, an independent power producer that also ran into trouble. Since then, MidAmerican, a company controlled by Berkshire Hathaway, Warren Buffett's investment vehicle, has gained a reputation as a company that buys astutely at the bottom of the market. It has since made very lucrative loans to Williams and CentrePoint, and project lenders had hoped that it might be a source of dealflow for their parched loan books.
But Kern River is, and remains, even after a series of changes in finance personnel, a standalone company. It is fiercely protective of its A3/A- rating ? one of the best in project finance. Indeed, much of the history of the pipeline's financing has been that of keeping the cost of borrowing as low as possible. It has led to a number of skirmishes with regulators over the costs of swaps, and has been a key factor in the retention of Credit Suisse First Boston (CSFB) as financial advisor, frequent bookrunner and lead arranger of its debt.
CSFB ran a bond in August 2001 to refinance the pipeline's debt, the fourth such effort, and the sale of the project to MidAmerican, for $450 million in cash and $150 million in assumed debt, made little impact on the line's financing strategy. CSFB was joined, however, by MidAmerican relationship bank Commerzbank, and CalEnergy bank Union Bank of California as mandated lead. What resulted was the loan equivalent of a mayfly ? a gorgeous, if short-lived, asset. Indeed, the only reason that it has such a long tenor ? 15 years ? is that the structure needed to be amortizing but could not deprive existing bondholders of too much cashflow.
The goal for the arrangers was to assemble a short-term package that would not interfere with existing debt but prove sufficiently saleable to banks. The indentures for the bond refinancing made clear that further debt would be raised on the project, and would share a security interest with bondholders. One incentive for existing investors was that the expansion had additional contracts in place of roughly the same creditworthiness.
The $875 million in bank debt will be taken out as promptly as is possible, and only exists because of the traditional aversion of bond investors to construction risk. A wrap from MidAmerican, therefore, covers the possibility of the expansion missing its due date for completion. Once this date is reached, a bond take-out of the debt waits simply upon favourable capital markets conditions.
The pricing on the debt carries clear penalties for delaying an issue, largely in terms of pricing. Nevertheless, the fact that the loan, which carries an 18-year term, will probably be prepaid in the second quarter of this year did not discourage participant banks from piling in, attracted by the fees as well as the temporary sweetening of battered loan books. Moreover Kern has a very solid relationship following in its own right.
Kern River does not presage any new financings from MidAmerican ? its acquisition of the Northern Natural Gas pipeline from Dynegy used corporate funds. However, as the largest non-recourse deal in the US, and the only significant non-power deal there, it came as useful succour to lenders, several of whom had to accept lower hold levels than they would have liked. Still, with pricing on the debt starting at 137.5bp over Libor, and manager roles fetching 70bp, most will be sorry to see the debt go. A refinancing is tentatively set for the middle of this year.
Kern River Transmission Company
Status: closed June 2002
Size: $1.2 billion
Location: Western US
Description: financing of an expansion to existing pipeline assets
Sponsor: MidAmerican Energy
Debt: $875 million
Arrangers: Commerzbank, Credit Suisse First Boston, Union Bank of California
Tenor: construction plus 15 yeaars
Lawyers to the borrower: Wilkie Farr & Gallagher
Lawyers to the lenders: Skadden, Arps, Slate, Meagher & Flom
Market consultant: Pace Global Energy
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